FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended September 30, 1998
Commission file number 0-24000
ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-0466020
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Erie Insurance Place, Erie, Pennsylvania 16530
(Address of principal executive offices) (Zip Code)
(814) 870-2000
Registrant's telephone number, including area code
Not applicable
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter periods
that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
___
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
Class A Common Stock, no par value, with a stated value of
$.0292 per share-- 67,032,000 shares as of October
31, 1998.
Class B Common Stock, no par value, with a stated value of
$70.00 per share-- 3,070 shares as of October 31,
1998.
The common stock is the only class of stock the Registrant is presently
authorized to issue.
INDEX
ERIE INDEMNITY COMPANY
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Position--September 30, 1998
and December 31, 1997
Consolidated Statements of Operations--Three and nine months ended
September 30, 1998 and 1997
Consolidated Statements of Comprehensive Income--Three and nine months
ended September 30, 1998 and 1997
Consolidated Statements of Cash Flows--Nine months ended
September 30, 1998 and 1997
Notes to Consolidated Financial Statements--September 30, 1998
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
PART I. FINANCIAL INFORMATION
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
September 30, December 31,
ASSETS 1998 1997
------------------- -----------------
(Unaudited)
INVESTMENTS
Fixed Maturities Available-for-Sale at fair value
(amortized cost of $375,840,267 and
$333,135,959, respectively) $ 396,336,782 $ 349,972,703
Equity Securities (cost of $179,827,248 and
$144,123,112, respectively) 193,319,712 165,132,504
Real Estate Mortgage Loans 8,300,585 8,392,518
Other Invested Assets 14,743,278 7,932,571
------------------- -----------------
Total Investments $ 612,700,357 $ 531,430,296
Cash and Cash Equivalents 54,029,787 53,148,495
Equity in Erie Family Life
Insurance Company 36,831,896 34,687,640
Accrued Investment Income 8,047,596 6,128,725
Premiums Receivable from Policyholders 115,966,607 108,057,986
Prepaid Federal Income Tax 0 1,681,573
Deferred Policy Acquisition Costs 11,224,416 10,283,372
Receivables from Erie Insurance Exchange
and Affiliates 527,365,776 495,861,158
Note Receivable from Erie Family
Life Insurance Company 15,000,000 15,000,000
Property and Equipment 11,381,458 10,130,230
Other Assets 33,142,382 26,134,306
------------------- -----------------
Total Assets $ 1,425,690,275 $ 1,292,543,781
=================== =================
3
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
------------------- -----------------
(Unaudited)
LIABILITIES
Unpaid Losses and Loss Adjustment Expenses $ 432,947,191 $ 413,408,941
Unearned Premiums 239,276,780 219,210,522
Accounts Payable and Accrued Expenses 13,898,948 9,785,773
Accrued Commissions 87,054,569 81,150,931
Accrued Vacation and Sick Pay 4,692,813 5,322,327
Deferred Compensation 2,395,223 1,933,020
Dividends Payable 7,255,444 7,255,444
Deferred Income Taxes 7,950,658 7,101,371
Federal Income Tax Payable 2,285,355 0
Accrued Benefit Obligations 10,520,421 7,992,300
------------------- ------------------
Total Liabilities $ 808,277,402 $ 753,160,629
------------------- ------------------
SHAREHOLDERS' EQUITY
Capital Stock
Class A Common, stated value $.0292
per share; authorized 74,996,930 shares;
issued and outstanding 67,032,000 shares $ 1,955,100 $ 1,955,100
Class B Common, stated value $70.00
per share; authorized 3,070 shares;
issued and outstanding 3,070 shares 214,900 214,900
Additional Paid-In Capital 7,830,000 7,830,000
Accumulated Other Comprehensive Income
net of deferred taxes of $14,320,365 and
$15,626,105, respectively 25,954,553 29,024,573
Retained Earnings 581,458,320 500,358,579
------------------- ------------------
Total Shareholders' Equity $ 617,412,873 $ 539,383,152
------------------- ------------------
Total Liabilities and
Shareholders' Equity $ 1,425,690,275 $ 1,292,543,781
=================== ==================
4
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------- -----------------------------------
MANAGEMENT OPERATIONS: 1998 1997 1998 1997
Management Fee Revenue $ 129,046,712 $ 122,875,909 $ 376,555,339 $ 360,124,010
Service Agreement Revenue 3,944,646 1,830,528 9,886,891 4,158,813
Other Operating Revenue 369,086 352,841 1,116,876 1,414,073
----------------- ------------------ ------------------ ---------------
Total Revenue from Management Operations 133,360,444 125,059,278 387,559,106 365,696,896
Cost of Management Operations 93,313,277 88,518,472 274,686,379 262,039,214
----------------- ------------------ ------------------ ---------------
Net Revenue From
Management Operations $ 40,047,167 $ 36,540,806 $ 112,872,727 $ 103,657,682
----------------- ------------------ ------------------ ---------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums Earned $ 28,387,446 $ 27,099,189 $ 83,995,073 $ 79,838,028
Losses and Loss Adjustment Expenses Incurred 19,653,955 19,790,114 58,604,908 59,015,371
Policy Acquisition and Other Underwriting
Expenses 8,830,200 7,608,033 24,366,116 21,952,443
----------------- ------------------ ------------------ ---------------
Total Losses and Expenses 28,484,155 27,398,147 82,971,024 80,967,814
----------------- ------------------ ------------------ ---------------
Underwriting (Loss) Gain $ (96,709) $ (298,958) $ 1,024,049 $ (1,129,786)
----------------- ------------------ ------------------ ---------------
INVESTMENT OPERATIONS:
Equity in Earnings of Erie Family
Life Insurance Company $ 792,289 $ 1,195,419 $ 3,401,333 $ 3,145,218
Net Investment Income 9,824,865 8,348,099 27,900,142 23,675,896
Realized Gain on Investments 1,230,011 2,205,947 5,416,377 4,703,031
----------------- ------------------ ------------------ ---------------
Revenue from Investment Operations 11,847,165 11,749,465 36,717,852 31,524,145
----------------- ------------------ ------------------ ---------------
Income Before Income Taxes 51,797,623 47,991,313 150,614,628 134,052,041
Provision for Income Taxes 16,101,086 15,863,037 47,748,551 43,269,202
----------------- ------------------ ------------------ ---------------
Net Income $ 35,696,537 $ 32,128,276 $ 102,866,077 $ 90,782,839
================= ================== ================== ===============
Net Income per Share $ 0.48 $ 0.43 $ 1.38 $ 1.22
================= ================== ================== ===============
Dividends Declared per Share:
Class A non-voting Common $ 0.1075 $ 0.095 $ 0.3225 $ 0.285
----------------- ------------------ ------------------ ---------------
Class B Common $ 16.125 $ 14.25 $ 48.375 $ 42.75
----------------- ------------------ ------------------ ---------------
5
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------- -----------------------------------
1998 1997 1998 1997
Net Income $ 35,696,537 $ 32,128,276 $ 102,866,077 $ 90,782,839
----------------- ------------------ ------------------ --------------
Unrealized Gains (Losses) on Securities:
Unrealized Holding (Losses) Gains Arising
During Period (16,780,584) 16,174,344 693,271 26,200,086
Less: Reclassification Adjustment for
Gains Included in Net Income 1,230,011 2,205,947 5,416,377 4,703,031
----------------- ------------------ ------------------ --------------
Net Unrealized Holding (Losses) Gains
Arising During Period $ (18,010,595) $ 13,968,397 $ (4,723,106) $ 21,497,055
Income Tax Benefit (Expense) Related to
Unrealized Gains or Losses 6,303,708 (4,888,939) 1,653,087 (7,523,969)
----------------- ------------------ ------------------ --------------
Other Comprehensive (Loss) Income, Net of Tax $ (11,706,887) $ 9,079,458 $ (3,070,019) $ 13,973,086
----------------- ------------------ ------------------ --------------
Comprehensive Income $ 23,989,650 $ 41,207,734 $ 99,796,058 $ 104,755,925
================= ================== ================== ==============
6
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 102,866,077 $ 90,782,839
Adjustment to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,512,252 1,366,444
Deferred income tax expense 1,973,432 1,099,882
Realized gain on investments (5,416,377) (4,703,031)
Amortization of bond discount (100,054) (103,771)
Undistributed earnings of Erie Family Life (2,481,579) (2,317,438)
Deferred compensation 462,203 203,960
Increase in accrued investment income (1,918,871) (1,155,486)
Increase in receivables (39,159,997) (40,286,641)
Policy acquisition costs deferred (16,843,061) (16,010,661)
Amortization of deferred policy acquisition costs 15,902,016 14,943,583
Increase in prepaid expenses and
other assets (6,880,040) (6,299,488)
Increase in accounts payable and
accrued expenses 6,011,782 1,384,177
Increase in accrued commissions 5,903,638 8,119,998
Increase in income taxes payable 3,966,928 3,895,709
Increase in loss reserves 19,538,250 23,861,937
Increase in unearned premiums 20,066,258 13,036,317
------------------ -----------------
Net cash provided by operating
activities $ 105,402,857 $ 87,818,330
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities (68,532,043) (50,847,456)
Equity securities (63,385,866) (47,168,709)
Mortgage loans 0 (1,183,667)
Other invested assets (9,847,958) (860,241)
Sales/maturities of investments
Fixed maturities 26,707,619 27,946,620
Equity securities 32,267,890 39,449,450
Mortgage loans 92,124 94,319
Other invested assets 3,087,762 290,538
Purchase of property and equipment (340,834) (34,469)
Purchase of computer software (2,422,645) (1,265,422)
Loans to Agents (1,452,913) (1,043,025)
Collections on Agent loans 1,071,634 902,497
------------------ -----------------
Net cash used in investing activities $ (82,755,230) $ (33,719,565)
CASH FLOW FROM FINANCING ACTIVITIES
Dividends paid to shareholders $ (21,766,335) $ (19,235,364)
------------------ ------------------
Net cash used in financing activities $ (21,766,335) $ (19,235,364)
------------------ ------------------
Net increase in cash and cash equivalents 881,292 34,863,401
Cash and cash equivalents at beginning of period 53,148,495 18,719,624
------------------ -----------------
Cash and cash equivalents at end of period $ 54,029,787 $ 53,583,025
================== =================
Supplemental disclosures of cash flow information:
Cash paid during the nine months ended September 30, 1998 and 1997 for income
taxes was $45,016,115 and $39,920,994 respectively.
See Notes to Consolidated Financial Statements.
7
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include the
accounts of the Erie Indemnity Company and its' wholly owned subsidiaries Erie
Insurance Company, Erie Insurance Company of New York and Erie Insurance
Property & Casualty Company, have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
nine-month period ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Form 10-K for the year ended December 31,
1997.
NOTE B -- RECLASSIFICATIONS
Certain amounts as previously reported in the 1997 financial statements have
been reclassified to conform to the current year's presentation.
NOTE C -- EARNINGS PER SHARE
Earnings per share is based on the weighted average number of Class A shares
outstanding (67,032,000 as retroactively stated in 1997), giving effect to the
conversion of the weighted average number of Class B shares outstanding (3,070
in 1998 and 1997) at a rate of 2,400 Class A shares for one Class B share as set
out in the Articles of Incorporation. Equivalent shares outstanding total
74,400,000.
NOTE D -- INVESTMENTS
Management considers all fixed maturities and marketable equity securities
available-for-sale. Marketable equity securities consist primarily of common and
nonredeemable preferred stocks while fixed maturities consist of bonds and
notes. Available-for-sale securities are stated at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity. Management determines the appropriate classification of
fixed maturities at the time of purchase and reevaluates such designation as of
each statement of financial position date.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following is a summary of available-for-sale securities:
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
September 30, 1998
U.S. Treasuries & Agencies $ 13,018 $ 838 $ 0 $ 13,856
States & Political Subdivisions 41,662 3,380 0 45,042
Special Revenue 123,951 7,975 0 131,926
Public Utilities 12,353 335 0 12,688
Industrial & Miscellaneous 177,706 9,007 640 186,073
Foreign Governments 1,990 0 464 1,526
Foreign Industrial & Miscellaneous 5,160 168 102 5,226
------------- ------------ ------------- -------------
Total Fixed Maturities $ 375,840 $ 21,703 $ 1,206 $ 396,337
------------- ------------ ------------- -------------
Common Stock $ 69,239 $ 23,508 $ 13,712 $ 79,035
Preferred Stock 110,588 5,090 1,393 114,285
------------- ------------ ------------- -------------
Total Equity Securities $ 179,827 $ 28,598 $ 15,105 $ 193,320
------------- ------------ ------------- -------------
$ 555,667 $ 50,301 $ 16,311 $ 589,657
============= ============ ============= =============
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
December 31, 1997
U.S. Treasuries & Agencies $ 12,771 $ 432 $ 3 $ 13,200
States & Political Subdivisions 41,931 2,840 0 44,771
Special Revenue 116,052 7,850 1 123,901
Public Utilities 7,171 160 0 7,331
U.S. Industrial & Miscellaneous 150,666 6,317 401 156,582
Foreign Governments 1,989 0 418 1,571
Foreign Industrial & Miscellaneous 2,556 61 0 2,617
------------- ------------ ------------- -------------
Total Fixed Maturities $ 333,136 $ 17,660 $ 823 $ 349,973
------------- ------------ ------------- -------------
Common Stock $ 64,762 $ 23,082 $ 7,674 $ 80,170
Preferred Stock 79,361 5,603 1 84,963
------------- ------------ ------------- -------------
Total Equity Securities $ 144,123 $ 28,685 $ 7,675 $ 165,133
------------- ------------ ------------- -------------
$ 477,259 $ 46,345 $ 8,498 $ 515,106
============= ============ ============= =============
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Mortgage loans on real estate are recorded at unpaid balances, adjusted for
amortization of premium or discount. A valuation allowance is provided for
impairment in net realizable value based on periodic valuations. The change in
the allowance is reflected on the income statement in realized gain (loss) on
investments.
Other invested assets (primarily investments in real estate limited
partnerships) are recorded under the equity method of accounting.
NOTE E -- SUMMARIZED FINANCIAL STATEMENT INFORMATION OF AFFILIATE
The Company has a 21.63% investment in Erie Family Life Insurance Company (EFL)
and accounts for this investment using the equity method. The following
represents summarized financial statement information for EFL:
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
Revenues $ 70,773,994 $ 67,366,531
Benefits and expenses 46,230,129 44,725,322
------------------ ------------------
Income before income taxes 24,543,865 22,641,209
Income taxes 8,818,793 8,100,211
------------------ ------------------
Net income $ 15,725,072 $ 14,540,998
================== ==================
Dividends paid to shareholders $ 4,110,752 $ 3,732,756
================== ==================
Net unrealized appreciation (depreciation) on
investment securities at September 30, net of
deferred taxes $ 18,876,966 $ 17,662,865
================== ==================
NOTE F -- NOTE RECEIVABLE FROM ERIE FAMILY LIFE INSURANCE COMPANY
On December 29, 1995, EFL issued a surplus note to the Company in return for
cash of $15 million. The note bears an annual interest rate of 6.45% and all
payments of interest and principal of the note may be repaid only out of
unassigned surplus of EFL and are subject to prior approval of the Pennsylvania
Insurance Commissioner. Interest on the surplus note is scheduled to be paid
semi-annually. The note will be payable on demand on or after December 31, 2005.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
financial statements and related notes found on pages 3 through 10, since they
contain important information that is helpful in evaluating the Company's
operating results and financial condition.
OPERATING RESULTS
Financial Overview
Consolidated net income increased by 11.1% for the third quarter of 1998 to
$35,696,537, or $.48 per share, from $32,128,276 or $.43 per share, for the
third quarter of 1997. The improved management operations were largely
responsible for the increase in net income for the quarter.
For the nine months ended September 30, 1998, net income increased 13.3% to
$102,866,077 or $1.38 per share, from $90,782,839 or $1.22 per share reported
for the same period in 1997. Management operations improved as growth in
management fee revenue outpaced the cost of management operations. Insurance
underwriting operations improved in the first nine months of 1998 as a result of
generally favorable underwriting trends and claims and underwriting initiatives
recently begun. Revenue from investment operations grew 16.5% to $36,717,852 for
the nine months ended September 30, 1998 as the Company's cash flow was
invested.
RESULTS OF OPERATIONS
Analysis of Management Operations
Management fee revenue derived from the management operations of the Company,
which serves as attorney-in-fact for the Erie Insurance Exchange (the Exchange),
increased 5.0% to $129,046,712 for the three months ended September 30, 1998
from $122,875,909 for the three months ended September 30, 1997. Management fee
revenue increased 4.6% to $376,555,339 in the first nine months of 1998 compared
to $360,124,010 for the same period in 1997.
The direct and affiliated assumed premiums of the Exchange, upon which
management fee is based, grew by 3.9% for the third quarter of 1998 compared to
the third quarter of 1997. The rate of growth in management fee revenue was
greater than the rate of growth in direct and affiliated assumed premium of the
Exchange because the management fee rate charged the Exchange in the third
quarter of 1998 was 24.25% compared to a rate of 24% charged in the third
quarter of 1997. The Company's Board of Directors has the authority to change
the management fee rate at its discretion, but cannot exceed a rate of 25%. The
personal lines automobile market continues to be extremely competitive and rate
pressures have increased in many of the Exchange's operating territories. The
Exchange's overall premium growth was also negatively influenced by a rate
reduction in Pennsylvania workers compensation resulting from legislative
reforms and competitive pressures in workers compensation insurance in general.
The Exchange's involuntary automobile premiums have also decreased over the last
year as a result of fewer assignments from the Pennsylvania assigned risk plan.
Involuntary automobile business is written on substandard risks and historically
has produced underwriting results much worse than the preferred risks
voluntarily written by the Exchange. When the effect of the workers compensation
premium decrease and involuntary automobile insurance premium decrease are
excluded, the direct and affiliated assumed premiums of the Exchange increased
5.1% for the three months ended September 30,1998 when compared to the same
period in 1997.
On July 31, 1998 the Erie Insurance Group filed to lower its private passenger
auto insurance rates in Pennsylvania beginning January 1, 1999. This reduction
was sought as a result of favorable loss experience in Pennsylvania. On
October 27, 1998, the Pennsylvania Insurance Department approved this
filing. The overall effect of this filing is an estimated $53.2 million
reduction in premium in 1999. This rate decrease will
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
reduce the Company's net revenue from management operations by about
$7 million in 1999, assuming no change in the current management fee rate.
Service agreement revenue totaled $3,944,646 and $1,830,528 for the quarter
ended September 30, 1998 and 1997, respectively. Beginning September 1, 1997 the
Company was reimbursed by the Exchange for a portion of service charges
collected by the property/casualty insurers of the Group from Policyholders for
the costs incurred by the Company in providing extended payment terms on
policies written by them. These reimbursements totaled $2,145,313 for the three
months ended September 30, 1998 compared to $461,199 during the same period in
1997.
The cost of management operations increased 5.4% for the third quarter of 1998
to $93,313,277 from $88,518,472 during the third quarter of 1997.
Commissions are the largest component of the cost of management operations. The
Company is responsible for the payment of commissions to the independent Agents
who sell insurance products for the Company's subsidiaries and the Exchange, and
its subsidiary, Flagship City Insurance Company. The Agents receive commissions
based on fixed percentage fee schedules with different commission rates by
product line of insurance. Also included in commission expense are the costs of
promotional incentives for Agents and Agent contingency awards. Agent
contingency awards are based upon the underwriting profitability of the
insurance written and serviced by the Agent within the Erie Insurance Group of
companies.
Commission costs totaled $64,704,256 for the third quarter of 1998, a 6.8%
increase over the $60,560,557 reported in the third quarter of 1997. Commission
costs grew faster than the rate of growth in written premiums due to increased
provisions for agent contingency awards resulting from the improved
underwriting results experienced in 1998 and agent promotional incentives. The
growth in premiums written on a quarterly and year-to-date basis were 3.9%
and 3.5%,respectively.
The cost of management operations excluding commission costs, increased 2.3% for
the three months ended September 30, 1998 to $28,609,021 from $27,957,915
recorded in the third quarter of 1997 as productivity improvements and modest
growth in operating costs continued.
Personnel costs, including salaries, employee benefits, and payroll taxes, are
the second largest component in cost of operations, after commissions. The
Company's personnel costs totaled $16,635,552 for the three month period ended
September 30, 1998, compared to $17,173,201 for the same period in 1997, a
decrease of 3.1%. The 1998 decline is the result of increased expense
reimbursements from the Exchange. As attorney-in-fact for the Exchange, the
Company pays almost all expenses of the Group and allocates those costs to the
respective Company responsible for them in accordance with intercompany
agreements. Increased reimbursements in 1998 to the Company for personnel costs
of the loss adjustment function was the result of an increased percentage of
loss adjustment personnel to total personnel. The increased percentage resulted
in a larger share of staff department overhead being allocated to the loss
adjustment function resulting in higher reimbursements to the Company.
Net revenue from the Company's management operations increased 9.6% to
$40,047,167 for the three months ended September 30, 1998 from $36,540,806 for
the same period in 1997. For the nine months ended September 30, 1998 net
revenue from management operations totaled $112,872,727, an increase of 8.9%
when compared to the first nine months of 1997.
Analysis of Insurance Underwriting Operations
Insurance underwriting results are produced from the Company's property and
casualty insurance subsidiaries, Erie Insurance Company and Erie Insurance
Company of New York, which together assume a 5.5% share of the underwriting
results of the Erie Insurance Group under an intercompany reinsurance pooling
arrangement. Insurance underwriting operations improved to a loss of $96,709 in
the third quarter of
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
1998 compared to a loss of $298,958 in the third quarter of 1997. In the third
quarter of 1998, premiums earned increased 4.8% to $28,387,446 compared to
$27,099,189 for the same period in 1997. Losses, loss adjustment expenses and
other underwriting expenses incurred increased at a slower rate than premiums
earned, up 4.0% for the third quarter of 1998 amounting to $28,484,155 compared
to $27,398,147 for the prior year's third quarter. Claims and underwriting
initiatives recently enacted by the Company combined with generally favorable
underwriting trends, contributed positively to the underwriting results for the
first three quarters of 1998. For the nine months ended September 30, 1998 the
Company posted an underwriting gain of $1,024,049 compared to an underwriting
loss of $1,129,786 for the same period in 1997. Catastrophic losses, as
classified by the Company were $911,000 in the third quarter of 1998 compared to
$318,000 in the third quarter of 1997. Included in the other underwriting
expenses are assessments made by state insurance guaranty associations. These
assessments are mandated by statute and are used by the various state insurance
guaranty associations to guarantee the property and casualty policies of
companies that have become insolvent. These mandatory assessments totaled
$670,500 in the third quarter of 1998 compared to $6,200 in the third quarter of
1997.
The GAAP combined ratio for the Company's property and casualty insurance
operations improved to 98.8% for the nine months ended September 30, 1998
compared to a ratio of 101.4% for the same period in 1997. The GAAP combined
ratio represents the ratio of loss, loss adjustment, acquisition, and other
underwriting expenses incurred to premiums earned.
Analysis of Investment Operations
Revenue from investment operations for the third quarter of 1998 increased
slightly to $11,847,165 from $11,749,465 in the third quarter of 1997. Growth in
net revenue from investment operations in the third quarter of 1998 resulted
from a 17.7% increase in net investment income. This increase was offset by a
decrease in the equity in earnings of Erie Family Life Insurance Company, the
Company's life insurance affiliate, and decreased realized gains on investments.
The Company records income from its 21.63% investment in Erie Family Life under
the equity method of accounting. The earnings recognized from the Company's
investment in Erie Family Life totaled $792,289 in the third quarter of 1998
compared to $1,195,419 recorded in the third quarter of 1997. Realized gains on
investments were $1,230,011 in the third quarter of 1998 compared to $2,205,947
in the third quarter of 1997. The earnings recognized from the investment in EFL
increased to $3,401,333 for the nine months ended September 30, 1998 from
$3,145,218 for the same period in 1997.
FINANCIAL CONDITION
Investments
The Company's investment strategy takes a long-term perspective emphasizing
investment quality, diversification and superior investment returns. Investments
are managed on a total return approach that focuses on current income and
capital appreciation. The Company's investment strategy also provides for
liquidity to meet the short and long-term commitments of the Company. At
September 30, 1998, the Company's investment portfolio of investment-grade
bonds, common stock and preferred stock, all of which are readily marketable,
and cash and short-term investments, totaled $644 million, or 45.1%, of total
assets. These resources provide the liquidity the Company requires to meet
demands on its funds.
At September 30, 1998, 96.2% of total investments consist of fixed maturities
and equity securities. Mortgage loans and other invested assets represented only
3.8% of total investments at that date. Mortgage loans and real estate
investments have the potential for higher returns, but also carry more risk,
including less liquidity and greater uncertainty in the rate of return.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
The Company's investments are subject to certain risks, including interest rate
and reinvestment risk. Fixed maturity and preferred stock security values
generally fluctuate inversely with movements in interest rates. The Company's
corporate and municipal bond investments may contain call and sinking fund
features which may result in early redemptions. Declines in interest rates could
cause early redemptions or prepayments which could require the Company to
reinvest at lower rates.
At September 30, 1998, the Company's five largest investments in corporate debt
securities totaled $25.9 million, none of which individually exceeded $6.4
million. These investments had a market value of $27.8 million.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of the Company's ability to secure enough cash to meet
its contractual obligations and operating needs. Operating cash flows are
generated from management operations as the attorney-in-fact for the Exchange,
the net cash flow from the Erie Insurance Company's 5% and the Erie Insurance
Company of New York's .5% participation in the underwriting results of the
reinsurance pool with the Exchange, and the Company's investment income from
affiliated and non-affiliated investments. With respect to the management fee
cash flow, funds are generally received from the Exchange on a premiums
collected basis, as the Company pays commissions on premiums collected rather
than written premiums. The Company generates sufficient net positive cash flow
from its operations to fund its commitments and to build its investment
portfolio, thereby increasing future investment returns. The Company also
maintains a high degree of liquidity in its investment portfolio in the form of
readily marketable fixed maturities, common stocks and short-term investments.
Net cash flows provided by operating activities for the nine months ended
September 30, 1998 and 1997, were $105,402,857 and $87,818,330 respectively.
Dividends declared and paid to shareholders in the three months ended September
30, 1998 and 1997, totaled $7,255,444 and $6,411,787, respectively. There are
state law restrictions on the payment of dividends from the insurance
subsidiaries to the Company. No dividends were paid to the Company from its
property/casualty insurance subsidiaries during the first nine months of 1998.
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to deferred tax assets and
liabilities resulted in net deferred tax liabilities at September 30, 1998 of
$7,950,658 and at December 31, 1997 of $7,101,371.
The National Association of Insurance Commissioners (NAIC) standard for
measuring the solvency of insurance companies, referred to as Risk Based Capital
(RBC), is a method of measuring the minimum amount of capital appropriate for an
insurance company to support its overall business operations in consideration of
its size and risk profile. The RBC formula is used by state insurance regulators
as an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that potentially are inadequately capitalized. In
addition, the formula defines minimum capital standards that will supplement the
current system of low fixed minimum capital and surplus requirements on a
state-by-state basis. At December 31, 1997, the Company' property/casualty
insurance subsidiaries' financial statements prepared under Statutory Accounting
Practices are all substantially in excess of levels that would require
regulatory action.
At September 30, 1998 and December 31, 1997, the Company's receivables from its
affiliates totaled $527,365,776 and $495,861,158, respectively. These
receivables, primarily due from the Exchange, as a result of the management fee,
expense reimbursements and the intercompany reinsurance pool, potentially expose
the Company to concentrations of credit risk.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
ACCOUNTING PRONOUNCEMENTS
SOP 98-1 - Software Costs
During the first quarter of 1998, the Company adopted AICPA Statement of
Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". In accordance with SOP 98-1 the Company began
capitalizing internal use software costs. The adoption of this statement
resulted in an immaterial impact on 1998 net income.
YEAR 2000 READINESS DISCLOSURE
As financial services enterprises, Erie Indemnity Company and the property &
casualty insurance companies it manages are dependent on information systems to
conduct business. Like all companies with information and systems dependencies,
the Company is continually faced with significant information technology
challenges. Among these challenges is the so-called "Year 2000 Issue," the
inability of many computer systems to recognize dates beginning with the year
2000 and subsequent dates. References to the Company in the description below
pertain to the Company and the property & casualty insurance companies under
its' management.
The effect of the Year 2000 Issue cannot be exactly measured with certainty and
any forecasts about the effect of the Year 2000 Issue and remediation
projections are necessarily forward-looking statements and are subject to the
risks and uncertainties noted on page 17.
Company's State of Readiness
Work on correcting the Company's internal systems for Year 2000 began in the mid
1990's. The Company categorizes internal systems as general administration
systems, core property and casualty policy processing and core claims systems.
Management has also developed plans for personal computer (PC) applications
and embedded microchip technology to avoid complications that could occur if
these systems or adjunct applications were to fail. Finally, management is
developing test plans to assure external business contacts will be ready for
Year 2000 and in some cases, contingency plans to deal with any foreseeable
failures of any mission critical systems.
Internal Systems: Many of the Company's mission critical general administration
systems have been replaced over the past four years to take advantage of new
technology and to accommodate growth and related information needs. These
systems (and the completion dates of their replacement) were as follows: Human
Resources (1995); Payroll Administration (1995); General Ledger (1997);
Investment Accounting (1996); and Accounts Payable (projected December, 1998).
Each of these new systems is vendor certified to be fully Year 2000 compliant.
As of September 30, 1998, approximately 98 percent of the Company's core
insurance policy processing system code has been modified to be Year 2000
compliant. The remaining program modifications are expected to be completed by
the end of 1998 on this internally developed system. As program modifications
are completed, they are being tested individually and qualified to be
performing acceptably. Integrated business testing involving the entire
system is planned for the first quarter of 1999.
The Company's Claims System was developed and written in house. It was
implemented in 1994. The system was designed to accommodate four digit date
fields and is fully year 2000 compliant. Testing of it's operating
environment and interfaces are planned for the first quarter of 1999.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Personal Computers & Embedded Microchip Technology: The Company completed an
inventory of all microcomputers, software and embedded microchip systems in
1997. Since that time, measures have been taken to remediate known Year 2000
compliance issues, principally by replacement of non-compliant devices and
software. The inventory is scheduled for update before year-end 1998 and action
plans for remediation of any remaining non-compliant devices or software will be
in place before December 31, 1998. Final remedial actions planned are to be
completed before March 31, 1999, including testing of and/or contingency
planning for any applications or devices considered to be mission critical.
External Business Contacts: During the first four months of 1998, a complete
inventory of external parties who conduct business with the Company was
developed. The inventory was used as a basis to request certifications from
outside parties as to their year 2000 readiness. Substantially all of the
critical external parties contacted have confirmed that they will be compliant
within time frames that are acceptable to the Company.
During the fourth quarter of 1998, the Company will focus efforts on a second
inventory of key outside parties whom management believes support mission
critical operations of the Company. Dialogue with these vendors has been ongoing
throughout 1998. For this category of outside party, more extensive
qualification of their year 2000 readiness will be established. Qualification
will include some combination of testing and contingency planning depending upon
the circumstances and management's relative comfort level with the outside
parties state of readiness.
Cost to Address Year 2000 Issues
The Company did not establish a specific budget to address the Year 2000 Issue.
By including Year 2000 changes in the scope of each system development and
maintenance project, the solution to the Company's Year 2000 Issue became an
extension of all system projects. Initial estimates for remedial programs were
less than 9,000 hours. This does not include the effort to replace entire
software applications as those replacements were not done solely to solve the
Year 2000 problems.
Based upon known factors and the measures taken to date, management does not
anticipate significant future costs in order to address the Year 2000 Issue.
Costs anticipated include personnel costs (to test internal systems, test
external party interfaces, develop contingency plans and replace software and
hardware devices that are not year 2000 compliant), personal computer software
and hardware. Costs that have been incurred to date, have been charged to
operations as incurred. Estimates of both the cost incurred to date and
future costs are not material to the financial position and results of
operations of the Company.
Risk of the Company's Year 2000 Issues
The proper functioning of the Company's computer systems and applications is
critical to the continued operations of the Company. By addressing the Year 2000
Issue over several years in the ordinary course of business, the costs and
uncertainty associated with it have been reduced significantly. Management
believes that all systems and applications will be Year 2000 compliant
sufficiently in advance of January 1, 2000, and therefore, will not adversely
affect the operations of the Company.
It is possible that certain key external parties will certify their systems as
year 2000 compliant when in fact they are not. The inability of the Company to
respond to uncontrollable circumstances is always a concern. For example, if
numerous key third parties are unable to support the operations of the Company,
operations could be adversely affected. The Company as part of overall risk
management will be preparing contingency plans during the first six months of
1999 in response to the possibility of key third party failure. Management does
not anticipate, nor would management characterize these scenarios, as having a
greater than remote possibility of occurrence.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Company's Contingency Plans if a Vendor or the Company fail to Address Year
2000 Issues
This risk described above will be addressed through contingency planning. The
level of contingency planning will be commensurate with the relative importance
of the external party to the operations of the Company and the relative risk
that the party will be unable to operate satisfactorily in 2000. Such
contingency plans are being developed and will be finalized during the second
and third quarter of 1999.
The statements herein are forward-looking statements containing the beliefs of
management that involve risks and uncertainties. These risks and uncertainties
include but are not limited to, human or mechanical errors in correcting Year
2000 Issues; incorrect or improper (intentional or otherwise) representations by
third parties as to their compliance or remediation efforts; the failure of
third parties to follow through on their remediation efforts and the inability
to identify and/or locate processing chips that are subject to Year 2000
problems.
***********************************************************************
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995: Statements contained herein expressing the beliefs of management such as
those contained in the "Financial Condition - Investments", and the "Liquidity
and Capital Resources" sections hereof, and the other statements which are not
historical facts contained in this report are forward looking statements that
involve risks and uncertainties. These risks and uncertainties include but are
not limited to: legislative, judicial and regulatory changes, the impact of
competitive products and pricing, product development, geographic spread of
risk, weather and weather-related events, other types of catastrophic events,
securities markets fluctuations, and technological difficulties and
advancements.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The H.O. Hirt Trusts collectively own 2,340 shares of the Company's Class B
Common Stock. The Company's Class B Common Stock has the exclusive right to vote
in the election of directors of the Company. Since such shares represent 76.22%
of the outstanding shares of the Company's Class B Common Stock, the vote of the
H.O. Hirt Trusts is sufficient to determine the outcome of any election of
directors. The trustees of the H.O. Hirt Trusts are F. William Hirt, Chairman of
the Board of the Company, a director of the Company, a beneficial owner of more
than 10% of the Company's outstanding Class A Common Stock and a beneficiary of
one of the two H.O. Hirt Trusts; his sister, Susan Hirt Hagen, a director of the
Company, a beneficial owner of more than 10% of the Company's outstanding Class
A Common Stock and a beneficiary of the other H.O. Hirt Trust, and Mellon Bank,
N.A. ("Mellon"). Under the provisions of the H.O. Hirt Trusts, the shares of the
Company's Class B Common Stock held by the H.O. Hirt Trusts are to be voted as
directed by a majority of the three trustees.
Under the Pennsylvania Insurance Company Law and the Company's By-laws, the
candidates for election as directors of the Company are to be nominated by a
committee consisting solely of persons who are not officers or employees of the
Company or of any entity controlling, controlled by or under common control with
the Company and who are not beneficial owners of a controlling interest in the
voting securities of the Company. On March 11, 1998, the Nominating Committee of
the Company's Board of Directors nominated 12 persons as candidates for election
as directors of the Company at the Company's April 28, 1998 annual meeting of
shareholders. The 12 persons nominated did not include Thomas B. Hagen, the
husband of Susan Hirt Hagen, as a candidate for election as a director of the
Company at such annual meeting. Thomas B. Hagen had served as a director of the
Company since 1979.
On April 2, 1998, Susan Hirt Hagen, a director of the Company, filed petitions
in the Orphan's Court Division of the Court of Common Pleas of Erie County,
Pennsylvania (the "Court") seeking the removal of Mellon as a co-trustee of the
H.O. Hirt Trust with respect to Susan Hirt Hagen and as a co-trustee of the H.O.
Hirt Trust with respect to F. William Hirt. Among the relief requested by Susan
Hirt Hagen in the petitions was the grant of a preliminary injunction against
Mellon from voting the Class B Common Stock held by the H.O. Hirt Trusts for the
purpose of the election of directors at the Company's April 28, 1998 annual
meeting of shareholders. Because of the potential substantial harm to the
Company if the preliminary injunction were granted, the Company filed a petition
to intervene in the preliminary injunction proceedings which the Court granted
on April 20, 1998. Following a hearing on April 20, 1998, the Court issued an
opinion on April 21, 1998 and an order denying Susan Hirt Hagen's request for a
preliminary injunction. On April 28, 1998, the Company's 1998 annual meeting of
shareholders was held as scheduled and each of the candidates for election as a
director of the Company named in the Company's April 1, 1998 proxy statement was
elected as a director of the Company.
On June 3, 1998, the Company, because of its substantial interest in the outcome
of any matter involving a change in Mellon's status as a co-trustee of the H.O.
Hirt Trusts, petitioned the Court to intervene in the trial of the issues
remaining under Susan Hirt Hagen's petitions to remove Mellon as a co-trustee.
On June 24, 1998, the court denied the Company's petition, and, on July 13,
1998, the Company appealed the Court's denial to the Superior Court of
Pennsylvania which appeal remains pending. On August 5, 1998, Susan Hirt Hagen,
a director of the Company, filed a motion with the Superior Court of
Pennsylvania to quash the Company's appeal. On August 17, 1998, the Company
filed its response to Susan Hirt Hagen's motion to quash the Company's appeal.
On October 19, 1998, the Superior Court of Pennsylvania denied without prejudice
Susan Hirt Hagen's motion to quash the Company's appeal, and the Superior Court
of Pennsylvania established a schedule for the submission of briefs on the
merits of the Company's appeal.
During June and July 1998, substantial discovery took place involving Susan Hirt
Hagen's petitions to remove Mellon as co-trustee. In the ten days preceding the
scheduled trial date of July 30, 1998, discussions took place between counsel
for Mellon and counsel for Susan Hirt Hagen concerning a possible basis for
settlement of the pending litigation. These discussions involved the
circumstances under which Mellon might resign as co-trustee of the H.O. Hirt
Trusts and the establishment of procedures pursuant to which a successor trustee
would be appointed by the Court or by agreement of Susan Hirt Hagen and F.
18
Item 1. Legal Proceedings (Continued)
William Hirt. After a hearing conducted on July 30, 1998, the Court by letter
advised counsel for all parties that the Court would not approve the settlement
proposal that had been presented during the July 30, 1998 hearing, and that
Mellon was to advise the Court on or before August 21, 1998 whether a revised
settlement proposal would be submitted or whether the petitions to remove Mellon
as co-trustee should be scheduled for trial by the Court for some later
unspecified date.
On August 4, 1998, the Company filed a further petition with the Court seeking
the right to intervene in the proceedings insofar as the proceedings would
entail the possible approval of any settlement of the petitions to remove Mellon
as co-trustee or the appointment of a successor trustee to Mellon. On October
21, 1998, Mellon submitted to the Court a Petition to Resign Pursuant to and
upon the Fulfillment of Certain Conditions Precedent (the "Mellon Petition"). On
October 29, 1998, the Court conducted a hearing at which time, among other
things, the Court heard testimony from two potential successor corporate
trustees to Mellon, each of which potential successors, the Court was advised,
had the approval of Mellon, Susan Hirt Hagen and F. William Hirt. During that
same hearing, the Court indicated that it would accept the Mellon Petition and
would in the future enter an order providing for the granting of the Mellon
Petition, in conjunction with a further hearing on the matter of the appointment
of a successor corporate co-trustee and the final Court approval thereof. On
November 2, 1998, the Court scheduled such a further hearing for January 6,
1999.
Item 6. Exhibits and Reports on Form 8-K
Exhibit 27 - Financial Data Schedule
All other exhibits for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are applicable, and therefore, have been omitted.
The Company did not file any reports on Form 8-K during the three month period
ending September 30, 1998.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Erie Indemnity Company
(Registrant)
Date: November 13, 1998
/s/Stephen A. Milne
-------------------
(Stephan A. Milne, President & CEO)
/s/Philip A. Garcia
-------------------
(Philip A. Garcia, Executive Vice President & CFO)
20
7
0000922621
ERIE INDEMNITY COMPANY
1,000
9-MOS 9-MOS
DEC-31-1998 DEC-31-1997
SEP-30-1998 SEP-30-1997
396,337 334,053
0 0
0 0
193,320 161,246
8,301 8,383
0 0
612,700 511,246
54,030 53,583
(11) 121
11,224 10,608
1,425,690 1,290,024
432,947 410,287
239,277 229,974
0 0
0 0
0 0
0 0
0 0
2,170 2,170
607,413 511,279
1,425,690 1,290,024
83,995 79,838
31,301 26,821
5,416 4,703
0 0
58,605 59,015
24,366 21,952
0 0
150,615 134,052
47,749 43,269
0 0
0 0
0 0
0 0
102,866 90,783
1.38 1.22
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
